Momentum Investing. What is it?[]
Proponents of passive investments are content with returns equal to the S&P 500 and do not seek to predict market trends. They prefer to invest in index funds and wait quietly.
At the same time, other investors, encouraged by the performance of certain funds, choose active money management or try to pick stocks on their own to outperform the indexes.
Impulse investing. What it is.[]
The investment approach known as "Impulse Investing" occupies an intermediate position in the spectrum of strategies. It involves frequent but strictly regulated interventions in the composition of the investment portfolio, minimizing the personal influence of the investor.
The main principle of this method is buying assets at a low price and selling them when the price rises. However, this rule has a significant disadvantage.
Determining the profitability of stocks on the stock exchange in the moment is often difficult. Richard Driehaus, the creator of the momentum investing strategy, argued the opposite: it pays to buy stocks at high prices in order to sell them even higher. This is akin to finding the "greater fool" to sell overvalued stocks during stock bubbles, despite the risk of loss.
Impulse Investment Theory[]
Based on Newton's first principle applied to finance, it is assumed that an asset whose value moves in a certain direction will continue to move in the same way until it is affected by external factors. This approach is used to analyze trends in the stock market.
Investors often focus on the long-term trends of a security. A prolonged rise in a stock indicates the likelihood that it will continue to strengthen for several months.
In contrast, a prolonged decline indicates a potential further decline in value, which could be a sell signal. In such a case, it is wise to move capital into more secure assets, such as bonds, until the market improves. Such decisions are often fueled by mass psychology - the actions of the majority of market participants.
A study of the effectiveness of momentum-based strategies, using the U.S. stock market since 1927 as an example, shows the following:
-Pulse Investing: The graph clearly shows the success of the strategy when the stocks with the highest growth over the previous year were selected.
-Market Returns: For comparison, here is a line that shows the average increase in the value of a market portfolio over the same period.
Investors following a momentum strategy select the stocks with the highest momentum. These securities, if the market grows by 10.46% per year, are able to generate returns of up to 15.08%. The strategy is based on the psychology of players and the ability to capitalize on sustained market movements before they disappear.
Investors who have applied the Momentum strategy in the US market since 2009 have been successful, catching a wave of growth through the end of 2018. This approach involves following rules based on analyzing technical indicators that help select assets to invest in and determine the best times to buy and sell stocks. It is also important to take into account the companies' quarterly and year-to-date reporting.
Overview of Dynamic Assets[]
Dynamic assets are a broad range of investment instruments that include securities capable of outperforming an underlying market index. Such assets include:
-Growth Stocks: securities of companies with the potential to increase in value.
-Value Assets: stocks whose valuation is based on market value theory.
-Variable Volatility Securities: include stocks with high and low levels of price volatility.
-Cyclical and Protective Assets: stocks that respond to economic cycles and provide stability. When the market is rising, these assets often show impressive returns. However, during downturns, losses can be significant.
Using technical analysis to select stocks[]
Technical analysis is a key tool for increasing stock profitability. Mastering this technique may seem difficult, but it is not. You need to be able to analyze statistical data to predict the direction of price movements and trading volume of securities. In this article, I offer tips on how to use momentum investing strategies on your own.
Investment strategies can fail; no one could have foreseen a disaster like the coronavirus that wiped out about 5 trillion dollars. To minimize risk, you need to be constantly educated and closely monitor market trends.
Pulse Indicators for Investing[]
Let's explore the tools that improve your investment portfolio performance:
1.ROC stock indicator
The ROC (Rate of Change) indicator is a method of assessing the dynamics of the value of an asset for a selected period. To make the calculation, the formula is applied: ROC = [(Current Price / Price one month ago) - 1] × 100.
When the value of assets increases, they show positive growth according to the ROC criterion, outperforming the general market trends. In the opposite situation, when a stock's momentum declines, its ROC becomes negative. This warns investors that the asset is losing its growth prospects.
2. analyzing stocks using RSI
In order to evaluate the current dynamics and compare with the past data in the stock market, investors apply the RSI index, which is based on analyzing the closing prices of assets after the last trades.
The Relative Strength Index, abbreviated as RSI, is a technical analysis indicator in the financial world. It measures the speed and change in the movements of securities, usually within 14 trading cycles. It operates with values between 0 and 100, which helps determine when an asset is considered overbought or oversold.
RSI formula:
RSI = 100 - (100 / (1 + RS)) where RS is the ratio of the average price gain to the average loss for the specified period. The indicator helps traders to catch the moments of potential trend reversal in the market.
Relative Strength Index (RSI) above 70 warns about possible excessive buying on the market. In such a situation, it is risky to enter the market with purchases; it is recommended to consider selling assets or closing a part of investments. If you do not want to sell, you can reduce potential losses by moving your stop loss closer to the current market price.
When the RSI drops to 30 or below, it may signal that the stock is undervalued. Such a moment can be a good time to buy. If you already have open short positions, you should consider moving your stop loss towards the last price to minimize losses.
3. Moving averages for 50 and 200 days
When analyzing the dynamics of the asset price, special attention should be paid to the closing price, excluding the length of candlestick shadows. In this context, it is worth noting the simplicity and efficiency of using moving averages with periods of 50 and 200 days. These indicators give an idea of the average price for a selected period of time, which helps investors in decision making.
Investors often consider long-term trends by tracking the average price of assets over a significant period, such as six months. This helps reduce the "noise" of short-term fluctuations.
There is an informal rule among them: only acquire or increase a stake in a stock when its value is above the 200-day average, indicating a steady increase in value.
4. the Coppock Innovation Indicator
Definition of the Coppock Indicator. The Coppock Indicator is a unique tool for selecting investment targets. It serves to predict the beginning of bullish trends and is an indicator of long-term momentum. The creator, economist E. Coppock, was based on the assumption that market downturns cause investors to feel sadness, similar to mourning.
Coppock was inspired by the timing of grieving over the loss of loved ones, typically taking 11 to 14 months, to create his unique methodology for analyzing the market. He developed a formula that analyzes stock price changes using the S&P 500 Index as an example, applying 14- and 11-month intervals.
He further processes this data using a 10-period averaging function. Despite the simplicity of the approach, the results are surprisingly accurate. However, for a more reliable investment, it is recommended to combine it with other market analysis tools.
In conclusion[]
The decision to implement a strategy of momentum investing in the management of one's assets is left to the discretion of each investor. It is worth considering that in the event of sudden economic shocks, this approach may not guarantee the safety of capital.
This tactic is most effective in periods of sustained market growth, but it can also show positive results in times of economic downturns, like the market situation in the early 2000s.
In times of financial downturns, active investment tactics do not provide the high returns that high risk funds promise. Its advantage lies in minimizing losses.
There is a risk that if you try to enter the market with such a plan on the eve of a recession, you may face a delay in the growth of asset values compared to the dynamics of market indices.